Accounting and Budgeting

Services level - IV

Introduction to Fundamental
Accounting
 What is Accounting Mean?
 Accounting is the language of business and is called this because
all organizations set up an accounting information system to
communicate data to help people make better decisions.

 Accounting is a system that

 Identifies  Records Communicates relevant, reliable, and
comparable information about an organization’s business activities.
 What is Accounting Mean?
 Identifying means selecting transactions and events
relevant to an organization.
- Example: Sale, receipt of money.
 Recording means keeping a chronological log of
transactions and events measured in dollars and
classified and summarized in a useful format.
 Communicating means preparing accounting reports
such as financial statements, and analyzing and
interpreting these reports.
 What is Accounting Mean?
 Recordkeeping / Bookkeeping—is recording of transactions and
events, either manually or electronically of an organization’s day-to-
day activities.
 Recordkeeping is only ONE part of Accounting.

 Accounting—is the process of analyzing and drawing conclusions

from this information.

Example: bookkeeper of a shoe store keeps the day-to-day records

as to how many shoes are sold and what bills need to be paid;
 Accountant analyzes this data to evaluate the profitability and
health of the business.
 Users of Accounting Information

External Users Internal Users

•Lenders •Consumer Groups •Managers •Sales Staff

•Shareholders •External Auditors •Officers •Budget Officers
•Governments •Customers •Internal Auditors •Controllers
 Users of Accounting Information

External Users Internal Users

Financial accounting provides Managerial accounting provides

external users with financial information needs for internal
statements. decision makers.
 Business Entity Forms

Proprietorship
Proprietorship Partnership
Partnership Corporation
Corporation
 Corporation

• Owners of a corporation are called

shareholders (or stockholders).

• When a corporation issues only one

class of stock, we call it common stock
(or capital stock).
Ethical standards
Ethics—are beliefs that distinguish right from wrong; they
are accepted standards of good and bad behavior.
1. Goal of accounting is to provide useful information for
decisions. So there must be ethics in accounting.
2. Saying “Good ethics are good business”
3. Providers of accounting information often face ethical
choices as they prepare financial reports.
For example, these choices can affect the price a buyer
pays and the wages paid to workers
 Generally Accepted Accounting Principles
Financial
Financialaccounting
accountingpractice
practiceis
isgoverned
governedby
byconcepts
conceptsand
andrules
rules
known
knownasasgenerally
generallyaccepted
acceptedaccounting
accountingprinciples
principles(GAAP).
(GAAP).

GAAP—are rules that specify acceptable accounting practices.

GAAP aims to make information in financial statements
relevant, reliable, and comparable.
Relevant
Relevant Affects
Affectsthethedecision
decisionof
of
Information
Information its
itsusers.
users.

Reliable
Reliable Information
Information Is
Istrusted
trustedby
by
users.
users.

Comparable
Comparable Is
Ishelpful
helpfulin
incontrasting
contrasting
Information
Information organizations.
organizations.
 Setting Accounting Principles
Financial
FinancialAccounting
AccountingStandards
StandardsBoard
Board(FASB)
(FASB)is
is
the
theprivate
privategroup
groupthat
thatsets
setsboth
bothbroad
broadand
and
specific
specificprinciples.
principles.

The
TheSecurities
Securitiesand
andExchange
ExchangeCommission
Commission(SEC)
(SEC)isisthe
the
government
governmentgroup
groupthat
thatestablishes
establishesreporting
reportingrequirements
requirements
for
forcompanies
companiesthat
thatissue
issuestock
stockto
tothe
thepublic.
public.

International Accounting Standards Board (IASB)—issues

International Financial Reporting Standards (IFRS) that identify
preferred accounting practices, for example, when companies
wish to raise money from lenders and investors in different
countries.
Principles and Assumptions of Accounting
 General Principles —the basic assumptions, concepts, and
guidelines for preparing financial statements.
 Specific Principles—detailed rules used in reporting
business transactions and events.
A. Accounting Principles
i. Cost Principle
 Means that accounting information is based on actual cost.
 Cost is measure on a cash or equal-to-cash basis.
Cash: Cash is given for a service, its cost is measured as the
amount of cash paid.
Equal to Cash: If something besides cash is exchanged (i.e.
truck), cost is measured as the cash value of what is given up
or received.
Objectivity—information is supported by independent,
unbiased evidence; it demands more than a person’s opinion.
ii. Revenue Recognition Principle
 Revenue (sales) - is the amount received from selling
products and services.
 Revenue Recognition Principle - provides guidance on
when a company must recognize revenue.
 Recognize - means to record it.
Three important concepts:
 Revenue is recognized when earned.
 Proceeds from selling products and services need not be
in cash (can be credit sale).
 Revenue is measured by the cash received plus the cash
value of any other items received.
iii. Matching Principle
A company must record its expenses incurred to
generate the revenue reported.

iv. Full Disclosure Principle

Requires a company to report the details behind
financial statements that would impact users’
decisions.
 Objectivity Principle

Accounting information is supported by

independent, unbiased evidence.
 Accounting Assumptions

i. Going-Concern Assumption
Accounting information reflects a presumption
that the business will continue operating instead
of being closed or sold.
ii. Monetary Unit Assumption
We can express transactions and events in
monetary, or money units.
Money is the most common denominator in
business.
iii. Time Period Assumption
Presumes that the life of a company can be
divided into time periods, such as months and
years, and that useful reports can be prepared for
those periods.
iv. Business Entity Assumption
A business is accounted for separately from other
business entities, including its owner.
Separate information about each business is
necessary for good decisions.
 The Basic Accounting Equation

This is a mathematical equation which must

balance.

If assets total $300 and liabilities total $200,

then owners' equity must be $100.

Assets = Liabilities + Owners' Equity

For example

Google has total assets of approximately $40.5 billion.

Liabilities and owner’s equity are the rights or claims
against these resources.

Thus, Google has $40.5 billion of claims against its

$40.5 billion of assets. Claims of those to whom the
company owes money (creditors) are called liabilities.

Claims of owners are called owner’s equity. Google

has liabilities of $4.5 billion and owners’ equity of $36
billion.
 Accounting Equation

Assets
Assets = Liabilities
Liabilities + Equity
Equity

Liabilities &
Assets Equity
 Financial Statements

 Companies prepare four financial statements from the

summarized accounting data:
 An income statement presents the revenues and expenses and
resulting net income or net loss for a specific period of time.
 An owner’s equity statement summarizes the changes in
owner’s equity for a specific period of time.
 A balance sheet reports the assets, liabilities, and owner’s
equity at a specific date.
 A statement of cash flows summarizes information about the
cash inflows (receipts) and outflows (payments) for a specific
period of time.
Financial Statements
Let’s prepare the Financial Statements reflecting the
transactions we have recorded.

1. Income StatementFinancial
Statements
2. Statement of Owner’s Equity
3. Balance Sheet
4. Statement of Cash Flows
 Scott Company
Income Statement
For Month Ended December 31, 2004 Net income is the
Revenues: difference
Consulting revenue $ 3,000 between
Expenses:
Salaries expense 800 Revenues and
Net income $ 2,200 Expenses.

The income statement describes a

company’s revenues and expenses
along with the resulting net income or
loss over a period of time due to
earnings activities.
 Scott Company
Income Statement
For Month Ended December 31, 2004 The net income
of $2,200
Revenues:
Consulting revenue $ 3,000 increases
Expenses: Scott’s capital
Salaries expense 800
Net income $ 2,200 by $2,200.

The Statement of Scott Company

Owner’s Equity Statement of Owner's Equity
explains changes in For Month Ended December 31, 2004
equity from net income
(or net loss) and from J. Scott, Capital, Dec. 1, 2004 $ -
owner investments and
Plus: Investment by owner 20,000
withdrawals for a
period of time. Net income 2,200
Less: Withdrawals 500
J. Scott, Capital, Dec. 31, 2004 $ 21,700
 Scott Company
Statement of Owner's Equity
For Month Ended December 31, 2004

The
The Balance
BalanceSheet
Sheet J. Scott, Capital, Dec. 1, 2004 $ -
Plus: Investment by owner 20,000
describes
describesaacompany’s
company’s Net income 2,200
financial
financial position
positionatat aa
Less: Withdrawals
J. Scott, Capital, Dec. 31, 2004 $
500
21,700
point
point in
intime.
time.

Scott Company
Balance Sheet
December 31, 2004

Assets Liabilities & Equity

Cash $ 9,700 Accounts payable $ 1,200
Supplies 1,200 Notes payable 4,000
Equipment 16,000 Total liabilities 5,200
J. Scott, Capital 21,700
Total assets $ 26,900 Total liabilities and equity $ 26,900
Statement of Cash flow
All
businesses are involved in three
types of activity —
 Financing,
 Investing and
 Operating.
Statement of Cash flow

• Cash flow- is the total amount of money that

passing into and out of business activities.
• A summary of cash inflows (receipts) and
outflows (payments) for a specific period of
time.
• Report the cash receipt and cash payment of the
business entities for the specific period of time.
SECTION CASH FLOW ACTIVITIES

1. OPERATING ACTIVITIES
• A cash transaction that enter in to the
determination of net income and net loss and
cash payment for creditors.

• Operating activities are the principal revenue-

producing activities of the enterprise and
other activities that are not investing or
financing activities.
 Example
 Cash inflow – A collection of receivable, sale on
merchandise on cash, collection of interest revenue,
collection of dividend from investment in other co.
 Cash outflow- payment for creditors for purchase
inventory or supplies and other payment for business
operating costs, payment for interest on debit.
 2. INVESTING ACTIVITIES

• A cash transaction for the acquisition and sale of relatively

long term asset.
• Resources owned by a business are called assets.
Example
Purchase and sale Computers, delivery trucks, furniture,
buildings, etc.
Purchase or sale of productive asset. Like: building,
equipment or machine, land, truck, furniture or fixture, etc. And
Purchase or sale of other companies debt or equity long term
securities.
 3. FINANCING ACTIVITIES:
• A cash transaction related to cash investment
by the owners, borrowing and withdrawal.
• For the corporation form of business this
includes payment of dividend to stockholder,
issuance of equity or debt securities; repayment
of loan principal.
• NB: the cash balance at the beginning period is
added to the increase or decrease in cash for the
period to obtain the cash balance at the end of
the period.
 Scott Company
Statement of Cash Flows
For Month Ended December 31, 2004

Cash flows from operating activities:

Cash received from clients $ 3,000
Purchase of supplies (1,000)
Cash paid to employees (800)
Net cash provided by operating activities $ 1,200
Cash flows from investing activities:
Purchase of equipment (15,000)
Net cash used in investing activities (15,000)
Cash flows from financing activities:
Investment by owner 20,000
Borrowed at bank 4,000
Withdrawal by owner (500)
Net cash provided by financing activities 23,500
Net increase in cash $ 9,700
Cash balance, December 1, 2004 -
Cash balance, December 31, 2004 $ 9,700

The Statement of Cash Flows identifies cash

inflows and cash outflows over a period of time.
 Return on Assets (ROA)

Net income ÷ Average total assets

ROA
ROAisis viewed
viewed as
as an
an
indicator
indicator of
of operating
operating
efficiency.
efficiency.
 Activity
Johnny’s Car Repair Shop started the year
with total assets of $60,000 and total
liabilities of $40,000. During the year the
business recorded $100,000 in car repair
revenues, $55,000 in expenses, and dividends
of $10,000.
Required:
The net income reported by Johnny’s Car
Repair Shop for the year was